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January 28, 2014

Income Taxes Can No Longer Be Ignored in Estate Planning

Higher estate tax exemption intersects in important ways with income taxes

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Many moderately wealthy families no longer have to worry about estate taxes, thanks to the American Taxpayer Relief Act of 2012, which significantly increased the federal estate tax exemption.

The exemption, now permanent, comes to $5.34 million this year after being adjusted for inflation.

But this isn’t the end of the story, according to Patricia Annino, who heads up the estate planning practice at Prince Lobel Tye LLP in Boston.

Estate planners now have to examine how income tax intersects with estate tax during planning discussions with their clients, Annino wrote in a blog post last week.

If no federal estate tax will be due, giving an asset away during a person’s lifetime can result in overall higher taxes paid by the family, according to Annino. This could result in a significantly higher overall tax paid than if the asset were transferred at death.

State inheritance and estate taxes may also come into play, Annino noted, as those with an estate tax usually have a lower exemption than is available at the federal level. Retaining an asset until death can result in no federal estate tax, a state estate tax and a fresh start income tax basis for income tax purposes.

It is important for practioners to take these income tax considerations into account in determining which assets should be transferred during lifetime, at death and whether to individuals or charities, she said.

Annino touched briefly on intra-family installment sales of the family business or commercial real estate in the context of federal estate exemptions. For federal income tax purposes, she wrote, installment sales allow taxes to be proportionately spread out during the period that principal payments are made.

As to timing of charitable gifts, she noted that no deduction is available if the estate is not subject to federal estate tax.